Sentiment Risk Premia in the Cross-Section of Global Equity

Abstract

This paper introduces a new sentiment-augmented asset pricing model and provides a com-
prehensive understanding of the role of this sentiment-driven risk factors. We find that news and
social media search-based indicators are significantly related to excess returns of international
equity indices. Adding sentiment factors to both classical and more recent pricing models leads
to a significant increase in model performance. When it is estimated using the Fama-MacBeth
procedure, our modified pricing model implies positive estimates of the risk premium for pos-
itive sentiment and negative premia estimates for the negative sentiment factor. Our results
contribute to the explanation of global cross-sectional average excess returns and are robust to
augmenting the model with fundamental factors, momentum, idiosyncratic volatility, skewness,
kurtosis, and the returns on international currencies. When compared to competing definitions
of sentiment factors already popular in the literature, our new sentiment risk indicator turns
out to be superior in terms of out-of-sample predictive power.

Keywords: Asset pricing, behavioral finance, financial markets, investor sentiment, sentiment risk premium

JEL Classification: C53, G12, G41